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J an 18th 2014 | From the print edition
In this section
Following a new script
Leavened
Trading up
Private equity
Buy-out firms like selling to each other, much to their investors annoyance
IN THE popular imagination, private-equity moguls unearth their targets by scouring
obscure corners of the business world for corporate diamonds-in-the-rough. They buff
such firms up and sell them for a fortune a few years later. The truth is rather more
prosaic: often the buy-out barons merely take over companies owned by their private-
equity rivals. Once a rarity, these pass-the-parcel deals have become common. In 2013
they represented nearly half the deals in Europe by value, according to Preqin, a data
provider. Investors are grumbling that this defeats the point of private equity.
Reasons abound for the rise of secondaries, as the industry prefers to call such deals.
For one thing, finding fresh corporate meat is hard. Taking listed companies private is
tricky, since shareholders have enjoyed bumper returns of late and valuations are high.
Conglomerates, which used to hive off unloved divisions to private equity, are flush with
cash, which they started to stockpile as soon as the economy soured in 2008. At least in
Europe, they remain wary of big mergers and acquisitions, which typically involve selling
off expendable appendages to the likes of Blackstone or Carlyle. At the same time,
private-equity groups have plenty of companies to sell, notably the firms they bought in
the run-up to 2008, the industrys apogee. Five years on, investors are clamouring for a
payout, leaving private-equity funds eager to offload their stock.
Private-equity firms are not just forced sellers, they are also
forced buyers. Funds globally have nearly $400 billion of
cash on hand, about a third of it in Europe. Not spending the
full amount is tantamount to failure: better to do a so-so
second-hand deal than none at all. Some buy-out firms were
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left with slimmed-down teams in the aftermath of the crisis,
meaning they are hesitant to commit scarce staff to take on
a complex corporate spin-off. Secondary deals are easier:
many of the due-diligence papers can be dusted off from the
previous sale. The bankers who supplied the financing for
the deal the first time round are often on hand for a repeat.
Whereas a primary deal can take months or years of
preparatory work, a secondary one can be set up in weeks if
needed. Tertiaries are easier still.
Investors who back private-equity firmstypically pension
funds, endowments and the likeare less than happy with
the rise of secondaries. They offer much less scope for
operational improvements, the main way in which private-
equity firms purport to create value. Worse, the same
institutions have sometimes invested in both the fund doing
the buying and the one doing the selling. Strip away the
financial montages, and they are in essence buying firms
from themselves, with hefty transaction costs, including a 20% cut of the profit (if any) to
the managers of the divesting fund.
Buy-out executives point to a host of profitable secondaries, as well as to studies that
show that such deals are no less lucrative than other takeovers. Pets at Home, a
purveyor of dog toys which three private-equity funds have chewed over in a decade, will
deliver a handsome return for KKR if a proposed flotation goes ahead this year, for
instance.
Many private-equiteers worry, however, about earning a reputation as repeat buyers,
particularly in Europe. J oe Baratta, head of private equity at Blackstone, a buy-out titan,
recently said it was not a sign of health that three-quarters of big deals in the region
were secondaries. Things might change as the economy recovers, says Dwight Poler of
Bain Capital, a rival buy-out firm: multinationals might regain an appetite for divestments,
selling out of mature markets to focus on growth in emerging economies, say. Until then,
more investors will discover the dubious pleasures of back-to-back buy-outs.
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Private equity: Buy-in barons | The Economist http://www.economist.com/news/finance-and-economics/21594331-buy-...
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